Becker-DeGroot-Marschak Contract Valuation Disconnect

In Simple Words

Imagine offering people insurance on an airplane flight. Buyers are willing to pay $10 more if the policy promises to give them a tiny snack voucher whenever the flight is delayed by 10 minutes, but they only offer $10 more for a policy that pays $10,000 if the plane crashes. They react strongly to small, frequent perks they can picture easily, but fail to properly calculate the massive value of protection against rare catastrophic loss.

Research question

Standard microinsurance design assumes consumers hold rational expectations and correctly evaluate variations in financial contract terms. However, boundedly rational agricultural producers often misjudge the actuarial impact of structural contract changes, overvaluing minor payout tweaks while undervaluing major catastrophic coverage shifts.

Participants

N = 1,978 smallholder farmers (1,464 existing study participants and 514 new participants) across rural Andhra Pradesh, India.

Study Design

In-field incentive-compatible Becker-DeGroot-Marschak (BDM) mechanism eliciting real monetary willingness-to-pay across 4 distinct insurance contract variations (Real Policy, Modified Exit, Modified mm Payment, and Basis Risk).

Results

Mean willingness-to-pay for the real policy was Rs. 68.4 (median Rs. 70). Modifying the exit threshold increased expected payout value by Rs. 40-70 but only increased willingness-to-pay by Rs. 10.86 (p < 0.01); reducing per-mm shortfall payouts reduced expected value by Rs. 10-20 and reduced willingness-to-pay by Rs. 11.90 (p < 0.01). Introducing basis risk (distant station) halved valuation, reducing bids by Rs. 29.45 (p < 0.01).

Takeaway

Regulate private microinsurance contract structures to prevent insurers from exploiting consumer behavioral biases through high-frequency, low-value policy tweaks that under-protect against severe tail events.

Read alongside the research

Plain-English glossary

Original explanations, informed by the references below. Examples are illustrations, not data from the studies above. The research text stays unchanged.

Median

The middle number after arranging the values from smallest to largest. If there are two middle numbers, use their average.

ExampleFor the values 2, 4 and 12, the middle value is 4. The median is 4.

NIST · Measures of location ↗Read more about median →

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